Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

¨ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2013

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number: 000-33001

 

 

NATUS MEDICAL INCORPORATED

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   77-0154833

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1501 Industrial Road, San Carlos, CA 94070

(Address of principal executive offices) (Zip Code)

(650) 802-0400

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of issued and outstanding shares of the registrant’s Common Stock, $0.001 par value, as of August 2, 2013 was 30,745,831.

 

 

 


Table of Contents

NATUS MEDICAL INCORPORATED

TABLE OF CONTENTS

 

         Page No.  

PART I.

  FINANCIAL INFORMATION      3   

Item 1.

  Financial Statements      3   
 

Condensed Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012 (unaudited)

     3   
 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and six months ended June 30, 2013 and 2012 (unaudited)

     4   
 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2012 (unaudited)

     5   
 

Notes to Condensed Consolidated Financial Statements (unaudited)

     6   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      17   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      25   

Item 4.

  Controls and Procedures      26   

PART II.

  OTHER INFORMATION      27   

Item 1.

  Legal Proceedings      27   

Item 1A.

  Risk Factors      27   

Item 6.

  Exhibits      28   

Signatures

     29   

 

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PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

NATUS MEDICAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except share and per share amounts)

 

     June 30,
2013
    December 31,
2012
 
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 28,910      $ 23,057   

Accounts receivable, net of allowance for doubtful accounts of $3,346 in 2013 and $2,617 in 2012

     87,557        89,960   

Inventories

     38,906        40,756   

Prepaid expenses and other current assets

     5,975        6,379   

Deferred income tax

     8,631        8,719   
  

 

 

   

 

 

 

Total current assets

     169,979        168,871   

Property and equipment, net

     25,842        26,512   

Intangible assets

     103,180        96,594   

Goodwill

     97,364        92,048   

Other assets

     8,445        7,828   
  

 

 

   

 

 

 

Total assets

   $ 404,810      $ 391,853   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 25,811      $ 32,537   

Short-term borrowings

     —          11,300   

Current portion of long-term debt

     10,182        8,526   

Accrued liabilities

     24,007        32,938   

Deferred revenue

     11,951        13,305   
  

 

 

   

 

 

 

Total current liabilities

     71,951        98,606   

Long-term liabilities:

    

Long-term debt, net of current portion

     40,381        13,034   

Other liabilities

     3,779        3,038   

Deferred income tax

     9,341        8,423   
  

 

 

   

 

 

 

Total liabilities

     125,452        123,101   
  

 

 

   

 

 

 

Stockholders’ equity:

    

Common Stock, $0.001 par value, 120,000,000 shares authorized; shares issued and outstanding 30,751,056 in 2013 and 30,106,933 in 2012

     281,867        275,395   

Retained earnings

     19,101        11,638   

Accumulated other comprehensive loss

     (21,610     (18,281
  

 

 

   

 

 

 

Total stockholders’ equity

     279,358        268,752   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 404,810      $ 391,853   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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NATUS MEDICAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(unaudited)

(in thousands, except per share amounts)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2013     2012     2013     2012  

Revenue

   $ 82,250      $ 61,032      $ 168,084      $ 120,440   

Cost of revenue

     33,859        26,695        70,460        52,781   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     48,391        34,337        97,624        67,659   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Marketing and selling

     21,848        16,245        43,969        32,888   

Research and development

     8,626        6,585        16,801        13,331   

General and administrative

     11,759        10,890        25,837        20,395   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     42,233        33,720        86,607        66,614   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     6,158        617        11,017        1,045   

Other income (expense), net

     (523     297        (856     477   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before provision for income tax

     5,635        914        10,161        1,522   

Provision for income tax expense

     1,615        590        2,699        909   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 4,020      $ 324      $ 7,462      $ 613   
  

 

 

   

 

 

   

 

 

   

 

 

 

Foreign currency translation adjustment

     (998     (2,371     (3,329     (1,960
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ 3,022      $ (2,047   $ 4,133      $ (1,347
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

        

Basic

   $ 0.14      $ 0.01      $ 0.25      $ 0.02   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.13      $ 0.01      $ 0.24      $ 0.02   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares used in the calculation of earnings per share:

        

Basic

     29,666        28,921        29,685        28,888   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     30,468        29,697        30,470        29,610   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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NATUS MEDICAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)

 

     Six Months Ended
June 30,
 
     2013     2012  

Operating activities:

    

Net income

   $ 7,462      $ 613   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     6,313        5,864   

Provision for losses on accounts receivable

     232        346   

Warranty reserve

     771        411   

Loss on disposal of property and equipment

     26        11   

Share-based compensation

     3,179        2,536   

Excess tax (benefit) expense on the exercise of stock options

     (403     612   

Changes in operating assets and liabilities:

    

Accounts receivable

     4,574        (3,891

Inventories

     (448     6,638   

Prepaid expenses and other assets

     (112     96   

Accounts payable

     (6,473     (484

Deferred income tax

     (984     (443

Accrued liabilities and deferred revenue

     (9,463     1,773   
  

 

 

   

 

 

 

Net cash provided by operating activities

     4,674        14,082   
  

 

 

   

 

 

 

Investing activities:

    

Acquisition of businesses, net of cash acquired

     (18,600     (57,931

Purchases of property and equipment

     (1,514     (2,297

Purchase of intangible assets

     (768     —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (20,882     (60,228
  

 

 

   

 

 

 

Financing activities:

    

Proceeds from stock option exercises and ESPP purchases

     3,847        770   

Excess tax benefit (expense) on the exercise of stock options

     403        (612

Proceeds from short-term borrowings

     —          6,000   

Proceeds from long-term borrowings

     55,300        25,000   

Payments on borrowings

     (37,586     (93
  

 

 

   

 

 

 

Net cash provided by financing activities

     21,964        31,065   
  

 

 

   

 

 

 

Exchange rate changes effect on cash and cash equivalents

     97        (778
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     5,853        (15,859

Cash and cash equivalents, beginning of period

     23,057        32,816   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 28,910      $ 16,957   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

    

Cash paid for interest

   $ 946      $ 21   
  

 

 

   

 

 

 

Cash paid for income taxes

   $ 7,527      $ 2,865   
  

 

 

   

 

 

 

Non-cash investing activities:

    

Property and equipment included in accounts payable

   $ 268      $ 415   
  

 

 

   

 

 

 

Inventory transferred to property and equipment

   $ 719      $ 1,001   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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NATUS MEDICAL INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

1 – Basis of Presentation

The accompanying interim condensed consolidated financial statements of Natus Medical Incorporated (“Natus,” “we,” “us,” “our,” or the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Except as noted below, the accounting policies followed in the preparation of the interim condensed consolidated financial statements are consistent in all material respects with those presented in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Interim financial reports are prepared in accordance with the rules and regulations of the Securities and Exchange Commission; accordingly, they do not include all of the information and notes required by GAAP for annual financial statements. The interim financial information is unaudited, but reflects all normal adjustments that are, in the opinion of management, necessary for the fair presentation of our financial position, results of operations, and cash flows for the interim periods presented. The condensed consolidated balance sheet as of December 31, 2012 was derived from audited financial statements, but does not include all disclosures required by GAAP. The accompanying financial statements should be read in conjunction with the financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Operating results for the six months ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Recent Accounting Pronouncements

Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income—In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. (“ASU”) 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This topic requires us to provide information about the amounts reclassified out of accumulated other comprehensive income by component and the line items of net income to which significant amounts are reclassified. This topic is for annual and interim periods beginning after December 15, 2012. The update did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

2 – Business Combinations

Grass Technologies

On February 2, 2013, we completed an asset purchase of the Grass Technologies Product Group (“Grass”) from Astro-Med Inc. for a cash consideration of $18.6 million. Grass manufactures and sells clinically differentiated neurodiagnostic and monitoring products, including a portfolio of electroencephalography (EEG) and polysomnography (PSG) systems for both clinical and research use and related accessories and proprietary electrodes. The acquisition strengthened the Company’s existing neurology portfolio and provided new product categories. A total of $624,000 of direct costs associated with the acquisition was expensed as incurred and reported as a component of general and administrative expenses.

The Company has accounted for the acquisition as a business combination. Under the acquisition method of accounting, the assets acquired and liabilities assumed from Grass are recorded in the consolidated financial statements at their respective fair values as of the acquisition date. The excess of the purchase price over the fair value of the acquired net assets has been recorded as goodwill. Grass’s results of operations are included in the consolidated financial statements since February 2, 2013, the date of the acquisition.

Valuing certain components of the acquisition, primarily accounts receivable required us to make significant estimates that may be adjusted in the future; consequently, the purchase price allocation is considered preliminary. Final determination of these estimates could result in an adjustment to the preliminary purchase price allocation, with an offsetting adjustment to goodwill. As of June 30, 3013, there have been no adjustments to the preliminary purchase price.

 

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Approximately $5.2 million has been allocated to goodwill. Goodwill is calculated as the difference between the acquisition date fair value of the consideration transferred and the provisional values assigned to the assets acquired and liabilities assumed and represent primarily the expected synergies of combining the operations of the Company and the Grass business. None of the goodwill is expected to be deductible for tax purposes. In accordance with ASC 350-20, goodwill will not be amortized but instead will be tested for impairment at least annually (more frequently if certain indicators are present). In the event that management determines that the value of goodwill has become impaired, we will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made.

Grass’s revenue of $3.7 million and $5.9 million and income from operations of $687,000 and $1.0 million are included in our condensed consolidated statements of income and comprehensive income for the period from April 1, 2013 to June 30, 2013 and February 2, 2013 (acquisition date) to June 30, 2013, respectively.

Nicolet

We acquired the Nicolet neurodiagnostic business (“Nicolet”) from CareFusion on July 2, 2012 pursuant to a Share and Acquisition Purchase Agreement. The Nicolet business develops clinically differentiated neurodiagnostic and monitoring products, including a portfolio of electroencephalography (EEG) and electromyography (EMG) systems and related accessories, as well as vascular and obstetric Doppler sensors and connectivity products. The acquisition strengthened the Company’s existing neurology portfolio and provided new product categories. The acquisition also better positions the Company in international markets, as over 50 percent of the Nicolet business is in markets outside of the United States.

We acquired all of the outstanding common shares of CareFusion subsidiaries comprising the Nicolet business in the United States, Ireland, and the United Kingdom, and certain assets and liabilities of Nicolet sales divisions principally in China, Brazil, Germany, Italy, the Netherlands, and Spain for $55.5 million. A total of $3.3 million of direct costs associated with the acquisition were expensed as incurred and reported as a component of general and administrative expenses.

The acquisition has been accounted for as a business combination. Under the acquisition method of accounting, the assets acquired and liabilities assumed from Nicolet are recorded in the consolidated financial statements at their respective fair values as of the acquisition date. The excess of the purchase price over the fair value of the acquired net assets has been recorded as goodwill. Nicolet’s results of operations are included in the consolidated financial statements since July 2, 2012, the date of the acquisition.

During the six months ending June 30, 2013, we recorded adjustments to the preliminary purchase price allocation for deferred taxes that resulted in a net increase to goodwill of $256,000.

Pro forma financial information

The following unaudited pro forma information combining results of operations of the Company for the six months ended June 30, 2013 and 2012 are presented as if the acquisitions of Grass and Nicolet had occurred on January 1, 2012:

Unaudited Pro forma Financial Information

(in thousands)

 

     Six Months Ended
June 30,
 
     2013      2012  

Revenue

   $ 169,089       $ 179,238   

Income from operations

   $ 12,464       $ 2,484   

The unaudited pro forma financial information is provided for comparative purposes only and is not necessarily indicative of what actual results would have been had the acquisitions occurred on the dates indicated, nor does it give effect to synergies, cost savings, and other changes expected to result from the acquisitions. Accordingly, the pro forma financial results do not purport to be indicative of results of operations as of the date hereof, for any period ended on the date hereof, or for any other future date or period.

 

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For purposes of preparing the unaudited pro forma financial information for the period January 1, 2013 through June 30, 2013, Grass’s statement of operations for the period from January 1, 2013 to February 1, 2013 was combined with our consolidated statement of operations and comprehensive income (loss) for the six months ended June 30, 2013.

For purposes of preparing the unaudited pro forma financial information for the period January 1, 2012 through June 30, 2012, Grass’s statement of operations and Nicolet’s consolidated statement of revenue and direct expenses for the six months ended June 30, 2012 were combined with our consolidated statement of operations and comprehensive income (loss) for the six months ended June 30, 2012.

The unaudited pro forma consolidated results for the six month period ended June 30, 2013 reflect the historical information of Natus and Grass, adjusted for the following pre-tax amounts:

 

   

Additional amortization expense of $59,300 related to the fair value of identifiable intangible assets acquired;

 

   

Decrease of depreciation expense of $14,800 related to the fair value adjustment to property and equipment acquired;

 

   

Decrease in general and administrative expense of $624,000 related to the direct acquisition costs that were recorded in the unaudited pro forma financial information in the six months ended June 30, 2012.

The unaudited pro forma consolidated results for the six month period ended June 30, 2012 reflect the historical information of Natus, Grass and Nicolet, adjusted for the following pre-tax amounts:

 

   

Elimination of Nicolet’s historical intangible asset amortization expense of approximately $423,000;

 

   

Additional amortization expense related to Grass of $356,000 and Nicolet of $565,000 related to the fair value of identifiable intangible assets acquired;

 

   

Decrease of Grass’s depreciation expense of approximately $89,000 and Nicolet’s depreciation expense of approximately $782,000 related to the fair value adjustment to property and equipment acquired;

 

   

Increase in general and administrative expense relating to Grass’s direct acquisition costs of approximately $533,000 and Nicolet’s direct acquisition costs of $3.3 million;

 

   

Increase in cost of goods sold relating to Nicolet’s fair value inventory adjustments of $571,000.

3 – Basic and Diluted Earnings Per Common Share

Basic earnings per share is based upon the weighted average number of common shares outstanding during the period. Diluted earnings per share is based upon the weighted average number of common shares outstanding and dilutive common stock equivalents outstanding during the period. Common stock equivalents are options granted and shares of restricted stock issued under our stock awards plans and are calculated under the treasury stock method. Common equivalent shares from unexercised stock options and unvested restricted stock are excluded from the computation when there is a loss as their effect is anti-dilutive or if the exercise price of such unexercised options is greater than the average market price of the stock for the period.

For the three and six months ended June 30, 2013, common stock equivalents of 801,327 and 785,431 shares, respectively, were included in the weighted average shares outstanding used to calculate diluted earnings per share, while common stock equivalents of 1,583,695 and 1,552,230 shares, respectively, were excluded from the calculation of diluted earnings per share because the exercise price of the underlying options was greater than the average market price of the stock for the period.

For the three and six months ended June 30, 2012, common stock equivalents of 776,433 and 721,978 shares, respectively were included in the weighted average shares outstanding used to calculate diluted earnings per share, while common stock equivalents of 1,797,145 and 2,047,286 shares, respectively, were excluded from the calculation of diluted earnings per share because the exercise price of the underlying options was greater than the average market price of the stock for the period.

 

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4 – Inventories

Inventories consist of the following (in thousands):

 

     June 30,
2013
    December 31,
2012
 

Raw materials and subassemblies

   $ 19,206      $ 21,373   

Work in process

     3,214        3,085   

Finished goods

     20,907        19,795   
  

 

 

   

 

 

 

Total inventories

     43,327        44,253   
  

 

 

   

 

 

 

Less: Non-current inventories

     (4,421     (3,497
  

 

 

   

 

 

 

Inventories, current

   $ 38,906      $ 40,756   
  

 

 

   

 

 

 

At June 30, 2013 and December 31, 2012, the Company has classified $4.4 million and $3.5 million of inventories, respectively, as non-current. This inventory consists primarily of service components used to repair products pursuant to warranty obligations and extended service contracts, including service components for products we are not currently selling. Management believes that these inventories will be utilized for their intended purpose.

5 – Intangible Assets

The following table summarizes the components of gross and net intangible asset balances (in thousands):

 

    June 30, 2013     December 31, 2012  
    Gross
Carrying
Amount
    Accumulated
Impairment
    Accumulated
Amortization
    Net Book
Value
    Gross
Carrying
Amount
    Accumulated
Impairment
    Accumulated
Amortization
    Net Book
Value
 

Intangible assets with definite lives:

               

Technology

  $ 66,380        —        $ (23,066   $ 43,314      $ 63,880        —        $ (20,901   $ 42,979   

Customer related

    32,148        —          (8,885     23,263        26,948        —          (7,563     19,385   

Internally developed software

    10,558        —          (4,554     6,004        9,790        —          (4,045     5,745   

Patents

    2,812        —          (1,986     826        2,812        —          (1,925     887   

Backlog

    724        —          (724     —          724        —          (724     —     
 

 

 

     

 

 

   

 

 

   

 

 

     

 

 

   

 

 

 

Definite-lived intangible assets

    112,622          (39,215     73,407        104,154          (35,158     68,996   

Intangible assets with indefinite lives:

               

Tradenames

    33,770        (1,560     —          32,210        30,778        (1,560     —          29,218   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Intangibles before translation

    146,392        (1,560     (39,215     105,617        134,932        (1,560     (35,158     98,214   

Translation

    (2,854     —          417        (2,437     (1,864     —          244        (1,620
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total intangibles assets

  $ 143,538      $ (1,560   $ (38,798   $ 103,180      $ 133,068      $ (1,560   $ (34,914   $ 96,594   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Definite-lived intangible assets are amortized over their weighted average lives of 15 years for technology, 12 years for customer related intangibles, 7 years for internally developed software, and 14 years for patents. Intangible assets with indefinite lives are not subject to amortization.

Internally developed software consists of $9.6 million relating to costs incurred for development of internal use computer software and $943,000 for development of software to be sold.

Amortization expense related to intangible assets with definite lives was as follows (in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2013      2012      2013      2012  

Technology

   $ 1,096       $ 670       $ 2,165       $ 1,541   

Customer Related

     678         393         1,322         896   

Internally developed software

     244         580         509         1,201   

Patents

     30         40         61         101   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total amortization

   $ 2,048       $ 1,683       $ 4,057       $ 3,739   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Expected amortization expense related to amortizable intangible assets is as follows (in thousands):

 

Six months ending December 31, 2013

   $ 4,061   

2014

     7,849   

2015

     7,508   

2016

     6,674   

2017

     6,291   

2018

     6,120   

Thereafter

     34,904   
  

 

 

 

Total expected amortization expense

   $ 73,407   
  

 

 

 

6 – Goodwill

The carrying amount of goodwill and the changes in those balances are as follows (in thousands):

 

Gross Balance, December 31, 2012

   $ 112,048   

Accumulated impairment losses

     (20,000
  

 

 

 

Balance net of impairment losses, December 31, 2012

     92,048   

Goodwill as a result of acquisitions

     5,668   

Foreign currency translation

     (352
  

 

 

 

Balance, June 30, 2013

   $ 97,364   
  

 

 

 

7 – Property and Equipment, net

Property and equipment, net consist of the following (in thousands):

 

     June 30,
2013
    December 31,
2012
 

Land

   $ 4,286      $ 4,371   

Buildings

     11,009        11,422   

Leasehold improvements

     3,661        3,450   

Office furniture and equipment

     12,053        11,601   

Computer software and hardware

     11,106        10,114   

Demonstration and loaned equipment

     11,203        11,505   
  

 

 

   

 

 

 
     53,318        52,463   

Accumulated depreciation and amortization

     (27,476     (25,951
  

 

 

   

 

 

 

Total

   $ 25,842      $ 26,512   
  

 

 

   

 

 

 

Depreciation and amortization expense of property and equipment was approximately $1.2 and $2.3 million for the three and six months ended June 30, 2013, respectively, and was approximately $1.3 and $2.2 million for the three and six months ended June 30, 2012, respectively.

8 – Reserve for Product Warranties

We provide a warranty on all medical device products that is generally one year in length. We also sell extended service agreements on our medical device products. Service for domestic customers is provided by Company-owned service centers that perform all service, repair, and calibration services. Service for international customers is provided by a combination of Company-owned facilities and third-party vendors on a contract basis.

We have accrued a warranty reserve, included in accrued liabilities on the accompanying balance sheets, for the expected future costs of servicing products during the initial warranty period. We base the liability on actual warranty costs incurred to service those products. On new products, additions to the reserve are based on a combination of factors including the percentage of service department labor applied to warranty repairs, as well as actual service department costs, and other judgments, such as the degree to which the product incorporates new technology. The reserve is reduced as costs are incurred to honor existing warranty obligations.

 

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Table of Contents

The details of activity in the warranty reserve are as follows (in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2013     2012     2013     2012  

Balance, beginning of period

   $ 2,643      $ 2,275      $ 2,260      $ 2,157   

Acquisition warranty assumed

     —          —          191        —     

Warranty accrued for the period

     115        195        771        411   

Repairs for the period

     (688     (245     (1,152     (343
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 2,070      $ 2,225      $ 2,070      $ 2,225   
  

 

 

   

 

 

   

 

 

   

 

 

 

The estimates we use in projecting future product warranty costs may prove to be incorrect. Any future determination that our product warranty reserves are understated could result in increases to our cost of sales and reductions in our operating profits and results of operations.

9 – Share-Based Compensation

At June 30, 2013, we have two active plans that give rise to share-based compensation, the 2011 Stock Awards Plan and the 2011 Employee Stock Purchase Plan. The terms of awards granted during the six months ended June 30, 2013 and our methods for determining grant-date fair value of the awards were consistent with those described in the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012.

Detail of share-based compensation expense is as follows (in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2013      2012      2013      2012  

Cost of revenue

   $ 37       $ 62       $ 96       $ 112   

Marketing and sales

     202         275         472         527   

Research and development

     124         108         241         213   

General and administrative

     1,456         933         2,370         1,684   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,819       $ 1,378       $ 3,179       $ 2,536   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of June 30, 2013, unrecognized compensation expense related to the unvested portion of our stock options and other stock awards was approximately $16.5 million, which is expected to be recognized over a weighted average period of 3.1 years.

Stock Options

Activity in our stock options during the six months ended June 30, 2013 is as follows:

 

     Shares     Weighted
Average
Exercise
Price
     Weighted-
average
remaining
contractual
life (years)
     Aggregate
intrinsic
value

($ 000’s)
 

Outstanding, beginning of period

     3,882,239      $ 11.71         

Granted

     615,620      $ 14.10         

Exercised

     (419,285   $ 7.87         

Cancelled

     (419,305   $ 16.02         
  

 

 

         

Outstanding, end of period

     3,659,269      $ 12.06         4.0       $ 9,811   
  

 

 

         

Exercisable, end of period

     2,383,650      $ 11.38         2.0       $ 8,445   
  

 

 

         

Vested and expected to vest, end of period

     3,455,975      $ 11.99         3.75       $ 9,608   
  

 

 

         

The intrinsic value of options exercised during the six months ended June 30, 2013 was $2.4 million.

 

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Table of Contents

Restricted Stock Awards

Activity in our restricted stock awards (“RSAs”) during the six months ended June 30, 2013 is as follows:

 

     Shares     Weighted-
average grant
date fair
value
     Remaining cost
expected to be
recognized

($ 000’s)
 

Unvested, beginning of period

     690,890      $ 13.04      

Granted

     305,780      $ 14.08      

Vested

     (77,250   $ 12.54      

Forfeited

     (122,970   $ 12.83      
  

 

 

      

Unvested, end of period

     796,450      $ 13.52       $ 10,253   
  

 

 

      

We award restricted stock awards to U.S. employees of the Company that vest 50% upon the second anniversary of the vesting start date and 25% upon each of the third and fourth anniversaries of the vesting start date. We also award RSA’s to non-employee directors of the Company that vest on the first anniversary of the grant date.

At June 30, 2013 the fair market value of outstanding RSAs was $10.9 million and the weighted average remaining recognition period of unvested RSAs was 2.7 years. At December 31, 2012 the fair market value of outstanding RSAs was $7.7 million and the weighted average remaining recognition period was 2.6 years. The intrinsic value of RSAs equals their fair market value.

Restricted Stock Units

Activity in our restricted stock units (“RSUs”) during the six months ended June 30, 2013 is as follows:

 

     Shares     Weighted-
average
remaining
contractual
life (years)
     Aggregate
intrinsic value

($ 000’s)
 

Outstanding, beginning of period

     50,050        

Awarded

     30,890        

Released

     (475     

Forfeited

     —          
  

 

 

      

Outstanding, end of period

     80,465        1.71       $ 1,098   
  

 

 

      

We award restricted stock units to non-U.S. employees of the Company that vest 50% upon the second anniversary of the vesting start date and 25% upon each of the third and fourth anniversaries of the vesting start date.

At June 30, 2013 the aggregate intrinsic value of outstanding RSUs was $1.1 million and the weighted average remaining recognition period for unvested RSUs was 2.9 years. At December 31, 2012 the aggregate intrinsic value of outstanding RSUs was $559,000 and the weighted average remaining recognition period for unvested RSUs was 2.8 years.

10 – Other income (expense), net

Other income (expense), net consisted of (in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2013     2012     2013     2012  

Investment income

   $ 34      $ 4      $ 65      $ 9   

Interest expense

     (469     (8     (946     (16

Foreign currency exchange gain (loss)

     147        96        (50     356   

Other

     (235     205        75        128   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense), net

   $ (523   $ 297      $ (856   $ 477   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

11 – Income Taxes

Provision for Income Tax Expense

We recorded provisions for income tax of $1.6 and $2.7 million for the three and six months ended June 30, 2013, respectively. Our effective tax rate was 28.9% and 26.7% for the three and six months ended June 30, 2013, respectively.

We recorded provisions for income tax of $590,000 and $909,000 for the three and six months ended June 30, 2012, respectively. Our effective tax rate was 64.6% and 59.7% for the three and six months ended June 30, 2012, respectively.

Our effective tax rate for the six months ended June 30, 2013 differed from statutory tax rates primarily because of profits taxed in foreign jurisdictions with lower tax rates than the statutory rate and tax benefits related to the 2012 federal research and development tax credit by enactment of the American Taxpayer Relief Act of 2012 in January 2013 and domestic manufacturer deduction. The federal research and development credit and domestic manufacturer deduction benefited the effective tax rate for the six month period ended June 30, 2013 by approximately 4%.

Our effective tax rate for the six months ended June 30, 2012 differed from statutory tax rates primarily due to losses in one foreign jurisdiction for which we did not record a tax benefit.

There was an insignificant increase of unrecognized tax benefits for the six months ended June 30, 2013. Within the next twelve months it is possible our uncertain tax benefit may change within a range of approximately zero to $600,000. This change may impact the future effective tax rate and is a result of a lapse of statute of limitations, provided that no taxing authority conducts an examination.

Our tax returns remain open to examination as follows: U.S. Federal, 2009 through 2012, U.S. States 2008 through 2012 and significant foreign jurisdictions, 2009 through 2012.

12 – Restructuring Reserves

In January 2011, we adopted a reorganization plan that was designed to improve efficiencies in the operations of Medix, which we acquired in October 2010. During the three months ended September 30, 2011 we also initiated similar restructuring activities in Embla, which we acquired in September 2011. These restructuring activities were completed as of March 31, 2013.

In July 2012, we initiated an integration and reorganization plan related to the acquisition of Nicolet that is designed to eliminate redundant costs, improve efficiencies in operations, and to move to an indirect sales model in certain countries in Europe, where Nicolet had previously sold under a direct sales model. As a result of the Nicolet acquisition, we also initiated additional restructuring activities in Xltek. Substantially all of the costs associated with the integration and reorganization plan are associated with employee severance costs. Substantially all of the staff reductions were completed by March 31, 2013.

In January 2013, we adopted reorganization plans that are designed to continue to improve efficiencies in our operating units in Europe and Medix. These plans were further expanded during the second quarter of 2013 to include North America.

The balance of the restructuring reserve is included in accrued liabilities on the accompanying balance sheets. Employee termination benefits expensed are included as a part of general and administrative expenses.

Activity in the restructuring reserves for these plans for the six months ended June 30, 2013 is as follows (in thousands):

 

     2011
Plans
    July
2012 Plan
    2013
Plans
    Totals  

Balances at December 31, 2012

   $ 83      $ 2,662      $ —        $ 2,745   

Expensed

     4        211        1,208        1,423   

Cash payments

     (71     (1,272     (615     (1,958

Accrual reversal

     (16     (1,325     —          (1,341
  

 

 

   

 

 

   

 

 

   

 

 

 

Balances at June 30, 2013

   $ —        $ 276      $ 593      $ 869   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

13 – Debt and Credit Arrangements

At June 30, 2013 the Company had a $75 million credit facility consisting of a $25 million revolving credit line and a $50 million 5-year term loan with Wells Fargo Bank, National Association (“Wells Fargo”). The credit facility contains covenants, including covenants relating to liquidity and other financial measurements, and provides for events of default, including failure to pay any interest when due, failure to perform or observe covenants, bankruptcy or insolvency events, and the occurrence of a material adverse effect, and restricts our ability to pay dividends. We are in compliance with all covenants as of June 30, 2013. We have granted Wells Fargo a security interest in substantially all of our assets. We have no other significant credit facilities.

During the first quarter 2013 we borrowed $22 million under the credit facility principally to fund the Grass acquisition and to provide for other working capital needs. We had no additional borrowings in the second quarter.

The credit facility was increased to $75 million in June 2013 and the term was extended to five years. As part of the amended credit facility in June 2013, we converted $31.2 million of short-term revolving debt to a term loan, increasing the term loan from $18.8 million as of March 31, 2013 to $50 million as of June 30, 2013.

Long-term debt is comprised of the following (2013 and 2012 columns in thousands):

 

     June 30,
2013
    December 31,
2012
 

Term loan $50 million, interest at LIBOR plus 1.75%, due September 30, 2018 with term loan principle repayable in quarterly installments of $2.5 million

   $ 49,966      $ 20,834   

Term loan $2.9 million Canadian (“CAD”), interest at cost of funds plus 2.5%, due September 15, 2014 with principle repayable in monthly installments of $16,000 until August 15, 2014 and one final payment of $404,000 collateralized by a first lien on company owned land and building

     597        726   
  

 

 

   

 

 

 

Total

     50,563        21,560   

Less current portion of long-term debt

     (10,182     (8,526
  

 

 

   

 

 

 

Total long-term debt

   $ 40,381      $ 13,034   
  

 

 

   

 

 

 

Maturities of long-term debt as of June 30, 2013 are as follows (in thousands):

 

Six months ended December 31, 2013

   $ 5,091   

2014

     10,501   

2015

     10,000   

2016

     10,000   

2017

     10,000   

2018

     4,971   
  

 

 

 

Total

   $ 50,563   
  

 

 

 

At June 30, 2013 and December 31, 2012, the carrying value of total debt approximates fair market value. The fair value of the Company’s debt is considered a Level 2 measurement.

14 – Segment, Customer and Geographic Information

We operate in one reportable segment in which we provide healthcare products used for the screening, detection, treatment, monitoring and tracking of common medical ailments.

Our end-user customer base includes hospitals, clinics, laboratories, physicians, nurses, audiologists, and governmental agencies. Most of our international sales are to distributors who resell our products to end users or sub-distributors.

Revenue and long-lived asset information is as follows (in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2013      2012      2013      2012  

Consolidated Revenue:

           

United States

   $ 47,935       $ 34,145       $ 96,245       $ 64,484   

Foreign countries

     34,315         26,887         71,839         55,956   
  

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 82,250       $ 61,032       $ 168,084       $ 120,440   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

14


Table of Contents
     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2013      2012      2013      2012  

Revenue by End Market:

           

Neurology Products

           

Devices and Systems

   $ 31,146       $ 20,230       $ 65,906       $ 39,997   

Supplies

     15,234         9,109         30,680         16,730   

Services

     6,398         851         11,951         1,861   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Neurology Revenue

     52,778         30,190         108,537         58,588   
  

 

 

    

 

 

    

 

 

    

 

 

 

Newborn Care Products

           

Devices and Systems

     15,911         18,528         33,105         37,983   

Supplies

     11,670         11,235         23,138         21,886   

Services

     1,891         1,079         3,304         1,983   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Newborn Care Revenue

     29,472         30,842         59,547         61,852   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Revenue

   $ 82,250       $ 61,032       $ 168,084       $ 120,440   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     June 30,
2013
     December 31,
2012
 

Long-lived assets:

     

United States

   $ 10,510       $ 9,813   

Foreign countries

     15,332         16,699   
  

 

 

    

 

 

 

Totals

   $ 25,842       $ 26,512   
  

 

 

    

 

 

 

Long-lived assets consist principally of property and equipment, net of accumulated depreciation and amortization. During the three and six months ended June 30, 2013 and 2012, no single customer or foreign country contributed to more than 10% of revenue.

15 – Fair Value Measurements

ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Fair value is defined under ASC 820 as the exit price associated with the sale of an asset or transfer of a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes the following three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value:

Level 1 — Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets and liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 — Unobservable inputs that are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

 

15


Table of Contents

The fair value of our assets and liabilities subject to fair value measurements are as follows (in thousands):

 

     Fair Value as
of
     Fair Value Measurements as of
6/30/13 Using Fair Value Hierarchy
 
     6/30/13      Level 1      Level 2      Level 3  

Bank money market investments

   $ 1,148         —         $ 1,148         —     
  

 

 

       

 

 

    

Total

   $ 1,148         —         $ 1,148         —     
  

 

 

       

 

 

    
     Fair Value as
of
     Fair Value Measurements as of
12/31/12 Using Fair Value Hierarchy
 
     12/31/12      Level 1      Level 2      Level 3  

Bank money market investments

   $ 1,148         —         $ 1,148         —     
  

 

 

       

 

 

    

Total

   $ 1,148         —         $ 1,148         —     
  

 

 

       

 

 

    

The carrying amount of the Company’s long term debt approximates fair value based on Level 2 inputs since the debt carries a variable interest rate that is tied to the current LIBOR rate plus a spread.

Non-financial assets such as goodwill, intangible assets, and property, plant, and equipment are evaluated for impairment and adjusted to fair value using Level 3 inputs, only when impairment is recognized. Fair values are considered Level 3 when management makes significant assumptions in developing a discounted cash flow model based upon a number of considerations including projections of revenues, earnings and a discount rate. In addition, in evaluating the fair value of goodwill impairment, further corroboration is obtained using our market capitalization. No impairment was recorded in the first six months of 2013 and 2012.

16 – Immaterial Corrections to Prior Period Financial Statements

Certain amounts previously reported in the condensed consolidated statements of operations and comprehensive income (loss) and condensed statements of cash flows for the three and six month periods ended June 30, 2012 have been restated to reflect the correction of immaterial errors as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The errors were related primarily to purchase accounting adjustments. In addition, certain other errors related to the liability associated with product trade-ins, currency loss on translation of foreign debt, amortization of intangible assets, the tax benefit associated with the release of accruals for uncertain tax positions were identified and corrected. The errors are not material individually or in the aggregate.

A summary of the effects of the correction of these errors on our condensed consolidated financial statements for the three and six month periods ended June 30, 2012 are presented in the table below (in thousands):

 

     Three Months Ended
June 30, 2012
     Six Months Ended
June 30, 2012
 
     As
Previously
Reported
     As
Corrected
     As
Previously
Reported
    As
Corrected
 

Condensed Consolidated Statements of Operations and Comprehensive Income

          

Revenue

   $ 61,013       $ 61,032       $ 120,522      $ 120,440   

Cost of revenue

     26,771         26,695         52,812        52,781   

Gross profit

     34,242         34,337         67,710        67,659   

Income from operations

     805         617         966        1,045   

Income before provision for income tax

     1,090         914         1,420        1,522   

Net income

     445         324         803        613   

Basic earnings per share

   $ 0.02       $ 0.01       $ 0.03      $ 0.02   

Condensed Consolidated Statements of Cash Flows

          

Net income

         $ 803      $ 613   

Depreciation and amortization

           6,050        5,864   

Change in operating assets and liabilities

          

Inventories

           6,615        6,638   

Deferred income tax

           (1,098     (443

Accrued liabilities and deferred revenue

           2,054        1,773   

Net cash provided by operating activities

           14,061        14,082   

Exchange rate changes effect on cash and cash equivalents

           (757     (778

 

 

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Table of Contents
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Registered Trademarks and Tradenames

Natus®, AABR®, ABaer®, ALGO®, AOAE®, AuDX® Aura®, Balance Manager®, Balance Master®, Balance Shape®, Biliband®, Bio-logic®, Bo-JECT®, Brain Atlas®, Ceegraph®, CHAMP®, Clarity System®, Cochlea Scan®, Cool Cap®, CoolCare®, Comet®, Dantec®, Ear Couplers®, Ear Muffin®, EC2®, Echo Screen®, Embla US®, Embletta®, Enterprise®, EquiTest®, Fass®, Fischer-Zoth®, Flexicoupler®,Grass®,Grass Technologies®, Gumdrop®, Halo Ear Muffin®, Hawaii Medical®, Keypoint®, Keypoint AU®, Keypoint EU®, Keypoint JP®, MASTER®, Medelec®, Medix®, MedixI.C.S.A®, Navigator®, Neatnick®, neoBLUE®, Neurocom®, Neuromax®,Neurotrac®, NeuroWorks®, Nicolet®, NicoletElite®, Oxydome®, Panorama®, Pocket®, Polyview®, REMbrandt®, REMlogic®, Sandm an®, Scout®, Sleeprite®, Sleepscan®, Sleeptrek®, Smart Scale®, Sonamed®, Sonara®, Sonara TEK®, Stellate Notta®, STETHODOP®, SZAC®, TECA®, Tootsweet®, Traveler®, Treetip®,Twin®, VAC PAC®, VERSALAB®, Warmette®, Xact Trace®, Xltek® are registered trademarks of Natus Medical Incorporated and its subsidiaries. Accuscreen™, Bili Lite Pad™, Bili-Lite™, Biomark™, Circumstraint™, Coherence™, Deltamed™, inVision™, Medix MediLED™, MiniMuffs™, NatalCare™, Neometrics™ and Smartpack™ are non-registered trademarks of Natus and its subsidiaries. Solutions for Newborn CareSM is a non-registered service mark of Natus.

Overview

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) supplements the MD&A in the Annual Report on Form 10-K for the year ended December 31, 2012 of Natus Medical Incorporated. Management’s discussion and analysis should be read in conjunction with our condensed consolidated financial statements and accompanying footnotes, the discussion of certain risks and uncertainties contained in Part II, Item 1A of this report, our Annual Report filed on Form 10K for the year ended December 31, 2012 and the cautionary information regarding forward-looking statements at the end of this section. MD&A includes the following sections:

 

   

Our Business. A general description of our business;

 

   

2013 Second Quarter Overview. A summary of key information concerning the financial results for the three months ended June 30, 2013;

 

   

Application of Critical Accounting Policies. A discussion of the accounting policies that are most important to the portrayal of our financial condition and results of operations and that require significant estimates, assumptions, and judgments;

 

   

Results of Operations. An analysis of our results of operations for the periods presented in the financial statements;

 

   

Liquidity and Capital Resources. An analysis of capital resources, sources and uses of cash, investing and financing activities, off-balance sheet arrangements, contractual obligations and interest rate hedging;

 

   

Recent Accounting Pronouncements. See Note 1 to our Condensed Consolidated Financial Statements for a discussion of new accounting pronouncements that affect us; and

 

   

Cautionary Information Regarding Forward-Looking Statements. Cautionary information about forward-looking statements.

Our Business

Natus is a leading provider of healthcare products used for the screening, detection, treatment, monitoring and tracking of common medical ailments in newborn care, hearing impairment, neurological dysfunction, epilepsy, sleep disorders, and balance and mobility disorders. Product offerings include computerized neurodiagnostic systems for audiology, neurology, polysomnography, and neonatology, as well as newborn care products such as hearing screening systems, phototherapy devices for the treatment of newborn jaundice, head-cooling products for the treatment of brain injury in newborns, incubators to control the newborn’s environment, and software systems for managing and tracking disorders and diseases for public health laboratories.

 

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Table of Contents

End Markets

Our products address two primary end markets:

 

   

Neurology – Includes products for diagnostic electroencephalography (EEG), electromyography (EMG), intra-operative monitoring (IOM), diagnostic sleep analysis, or polysomnography (PSG), newborn brain monitoring, and assessment of balance and mobility disorders.

 

   

Newborn Care – Includes thermoregulation devices and products for the treatment of brain injury and jaundice in newborns and products for newborn hearing screening and diagnostic hearing assessment.

Segment and Geographic Information

We operate in one reportable segment in which we provide healthcare products used for the screening, detection, treatment, monitoring and tracking of common medical ailments.

Our end-user customer base includes hospitals, clinics, laboratories, physicians, nurses, audiologists, and governmental agencies. Most of our international sales are to distributors who resell our products to end-users or sub-distributors.

Information regarding our sales and long-lived assets in the U.S. and in countries outside the U.S. is contained in Note 14 – Segment, Customer and Geographic Information of our condensed consolidated financial statements included in this report.

Revenue by Product Category

We generate our revenue either from sales of Devices and Systems, which are generally non-recurring, and from related Supplies and Services, which are generally recurring. The products that are attributable to these categories are described in our Annual Report on Form 10-K for the year ended December 31, 2012. Revenue from Devices and Systems, Supplies and Services, as a percent of total revenue for the three and six months ended June 30, 2013 and 2012 is as follows:

 

     Three Months Ended
June 30,
    Six Months Ended
June  30,
 
     2013     2012     2013     2012  

Devices and Systems

     57     64     59     65

Supplies

     33     33     32     32

Services

     10     3     9     3
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     100     100     100     100

During the three and six months ended June 30, 2013 and 2012, no single customer or foreign country contributed to more than 10% of revenue.

2013 Second Quarter Overview

Our business and operating results are driven in part by worldwide economic conditions. Our sales are significantly dependent on both capital spending by hospitals in the United States and healthcare spending by ministries of health within the European Union.

Our consolidated revenue increased $21.2 million in the second quarter ended June 30, 2013 to $82.2 million compared to $61.0 million in the second quarter of the previous year. Grass contributed to $3.7 million of revenue and Nicolet contributed to $21.2 million of revenue in the second quarter of 2013. We experienced revenue increases across business units in Canada and declines across other business units in Europe, South America and the United States.

Net income was $4 million or $0.13 per diluted share in the three months ended June 30, 2013, compared with net income of $324,000 or $0.01 per diluted share in the same period in 2012. An increase from 56.3% to 58.8% in gross profit percentage for the second quarter of 2013 compared to same period in 2012 resulted primarily from improved margins associated with more favorable product mix.

Application of Critical Accounting Policies

We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In so doing, we must often make estimates and use assumptions that can be subjective, and, consequently, our actual results could differ from those estimates. For any given individual estimate or assumption we make, there may also be other estimates or assumptions that are reasonable.

 

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We believe that the following critical accounting policies require the use of significant estimates, assumptions, and judgments. The use of different estimates, assumptions, or judgments could have a material effect on the reported amounts of assets, liabilities, revenue, expenses, and related disclosures as of the date of the financial statements and during the reporting period:

 

   

Revenue recognition

 

   

Inventory is carried at the lower of cost or market value

 

   

Carrying value of intangible assets and goodwill

 

   

Liability for product warranties

 

   

Share-based compensation

These critical accounting policies are described in more detail in our Annual Report on Form 10-K for the year ended December 31, 2012, under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. There have been no changes to these policies during the six months ended June 30, 2013.

Results of Operations

The following table sets forth, for the periods indicated selected consolidated statements of operations data as a percentage of total revenue. Our historical operating results are not necessarily indicative of the results for any future period.

 

     Three Months
Ended

June 30,
    Six Months
Ended

June 30,
 
     2013     2012     2013     2012  

Revenue

     100     100     100     100

Cost of revenue

     41.2        43.7        41.9        43.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     58.8        56.3        58.1        56.2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Marketing and selling

     26.5        26.6        26.2        27.3   

Research and development

     10.5        10.8        10.0        11.1   

General and administrative

     14.3        17.9        15.4        16.9   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     51.3        55.3        51.6        55.3   

Income from operations

     7.5        1.0        6.5        0.9   

Other income (expense), net

     (0.6     0.5        (0.5     0.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before provision for income tax

     6.9        1.5        6.0        1.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Provision for income tax

     2.0        1.0        1.6        0.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     4.9     0.5     4.4     0.5
  

 

 

   

 

 

   

 

 

   

 

 

 

As the operations of Grass and Nicolet have been reflected in our consolidated results since their acquisition dates of February 2013 and July 2012, where significant, we have noted the impact of these acquisitions on our results of operations for the three and six months ended June 30, 2013, as compared to the same periods in 2012.

The following discussion reflects the effects of the corrections disclosed in Note 16 to the condensed consolidated financial statements.

Three Months Ended June 30, 2013 and 2012

Revenues

Our consolidated revenue increased by $21.2 million or 35% to $82.2 million for the three months ended June 30, 2013, compared to $61.0 million in the comparable 2012 period. The increase was attributable to our recent acquisitions. Grass, acquired in February 2013 contributed $3.7 million of revenue in the second quarter of 2013. Nicolet, acquired in July 2012 contributed $21.2 million of revenue in the second quarter of 2013. Revenue from our products other than Grass and Nicolet decreased by $3.7 million in 2013, compared to 2012, due in large part to our emphasizing the sale of the newly acquired products that serve the same markets as certain legacy products.

 

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Revenue from our neurology products increased $22.6 million or 75% to $52.8 million in the second quarter of 2013, compared to $30.2 million in the same period in 2012. Revenue from our neurology products, other than Grass and Nicolet products, decreased by $2.3 million for the three months ended June 30, 2013 compared to 2012. This decline was attributable to weak economic conditions in Europe coupled with a decline in domestic hospital capital spending and our emphasizing the sales of our newly acquired neurology products. Revenue from our newborn care products decreased by $1.3 million, or 4% to $29.5 million in the second quarter of 2013 compared to $30.8 million in the same period in 2012. This decline was primarily attributed to lower sales of newborn care devices and systems partially offset by an increase in newborn care supplies and services.

Revenue from neurology devices and systems was $31.1 million for the three months ended June 30, 2013, representing an increase of 54% or $10.9 million, from $20.2 million reported in the second quarter of 2012. Grass and Nicolet contributed to $12.9 million of the increase in neurology devices and systems while revenue from our neurology products other than Grass and Nicolet decreased by $2 million in the second quarter of 2013 compared to the second quarter of 2012, primarily attributable to a decrease in EMG revenue. Revenue from newborn care and other devices and systems was $15.9 million for the three months ended June 30, 2013, representing a decrease of 14% or $2.6 million, from $18.5 million reported in the second quarter of 2012. This decline in newborn care devices and systems revenue was due to lower sales of diagnostic hearing, CFM and balance monitoring products.

Revenue from devices and systems was 57% of consolidated revenue in the second quarter of 2013 compared to 63% of consolidated revenue in the second quarter of 2012.

Revenue from neurology supplies was $15.2 million for the three months ended June 30, 2013 representing an increase of 67% or $6.1 million, from $9.1 million reported in the second quarter of 2012. Grass and Nicolet contributed to $8.9 million of neurology supplies. Neurology supplies revenue other than Grass and Nicolet, decreased by $2.8 million in the second quarter of 2013 compared to the second quarter of 2012. This decline was primarily attributable to a decrease in Embla sleep supplies. Revenue from newborn care supplies was $11.7 million for the three months ended June 30, 2013, representing an increase of 4% or $500,000 from $11.2 million reported in the second quarter of 2012. This increase was comprised primarily of an increase in newborn care supplies partially offset by a decrease in hearing supplies.

Revenue from supplies was 33% of consolidated revenue in both the second quarter of 2013 and 2012, respectively.

Revenue from neurology services was $6.4 million for the three months ended June 30, 2013 representing an increase of 653% or $5.6 million, from $851,000 reported in the second quarter of 2012. Grass and Nicolet contributed to $3.1 million of the increase in neurology services. Neurology services revenue other than Grass and Nicolet increased by $2.5 million in the second quarter of 2013 compared to the second quarter of 2012. This increase was primarily attributable to Xltek service revenue. Revenue from newborn care services was $1.9 million for the three months ended June 30, 2013, representing an increase of 73% or $800,000 from $1.1 million reported in the second quarter of 2012. This increase was comprised primarily of hearing, newborn care and balance service revenue.

Revenue from services was 10% of consolidated revenue in the second quarter of 2013 compared to 3% of consolidated revenue in the second quarter of 2012.

No single customer accounted for more than 10% of our revenue in either the second quarter of 2013 or 2012. Revenue from domestic sales increased 40% to $47.9 million for the three months ended June 30, 2013 from $34.1 million in the second quarter of 2012. Revenue from international sales increased 28% to $34.3 million for the three months ended June 30, 2013 compared to $26.9 million in the second quarter of 2012. Revenue from domestic sales was 58% of total revenue for the three months ended June 30, 2013 compared to 56% of total revenue in the second quarter of 2012, and revenue from international sales was 42% of total revenue in the second quarter of 2013 compared to 44% of total revenue in the second quarter of 2012.

Cost of Revenue and Gross Profit

Our cost of revenue increased $7.2 million or 27% to $33.9 million for the three months ended June 30, 2013 from $26.7 million in the second quarter of 2012. Grass and Nicolet contributed $9.7 million to our cost of revenue coupled with cost of revenue declines across North America. Gross profit increased $14.1 million, or 41%, to $48.4 million in the second quarter of 2013 from $34.3 million in the second quarter of 2012 as a result of our improved margins associated with product mix. Gross profit as a percentage of revenue was 58.8% for the three months ended June 30, 2013 and 56.3% for the three months ending June 30, 2012. The increase in gross profit as a percentage of revenue was as the result of a higher percentage of sales of neurology products which generally carry higher margins than our other products.

 

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Operating Costs

Total operating costs increased $8.5 million or 25% to $42.2 million for the three months ended June 30, 2013, from $33.7 million in the second quarter of 2012.The operating costs of Grass and Nicolet contributed to $8.5 million in operating costs.

Our marketing and selling expenses increased $5.6 million or 34% to $21.8 million in the second quarter of 2013, from $16.2 million in the second quarter of 2012. Marketing and selling expenses as a percent of total revenue was 26.6% in both the second quarter of 2013 and 2012. The marketing and selling expenses of Grass and Nicolet and were $5.6 million comprising the entire increase in marketing and selling expenses

Our research and development expenses increased $2 million or 31% to $8.6 million for the three months ended June 30, 2013 from $6.6 million for the three months ended June 30, 2012. Research and development expenses as a percent of total revenue decreased to 10.5% in the second quarter of 2013 from 10.8% in the second quarter of 2012. The research and development expenses of Grass and Nicolet were $2.3 million for the three months ended June 30, 2013, partially offset by lower employee compensation costs resulting from restructuring activities initiated in 2012.

Our general and administrative expenses increased $900,000 or 8% to $11.8 million for the three months ended June 30, 2013 from $10.9 million for the three months ended June 30, 2012. General and administrative expenses as a percent of revenue decreased to 14.3% in the second quarter of 2013 from 17.8% in the second quarter of 2012. The general and administrative expense of Grass and Nicolet were $623,000. The newly enacted medical device tax in 2013 accounted for $1.2 million of general and administrative expenses for the three months ended June 30, 2013 offset by lower direct costs related to acquisitions.

Other Income (Expense), net

Other income (expense), net consists of investment income, interest expense, net currency exchange gains and losses, and other miscellaneous income and expense. We reported other income (expense), net of $(523,000) for the three months ended June 30, 2013, compared to $297,000 for the three months ended June 30, 2012. We reported $147,000 of foreign currency exchange gains in the second quarter of 2013 versus $96,000 of foreign exchange gains in the second quarter of 2012. Interest expense was $469,000 for the three months ended June 30, 2013 compared to $8,000 for the three months ended June 30, 2012 due primarily to additional borrowings to fund the Nicolet and Grass acquisitions.

Provision for Income Tax

We recorded a provision for income tax of $1.6 million and $590,000 for the three months ended June 30, 2013 and 2012, respectively. The increase in tax expense for the three months ended June 30, 2013 compared to the same period of 2012 is primarily attributable to the increase in income before provision for income taxes. Our effective tax rate was 28.7% and 64.6% for the three months ended June 30, 2013 and 2012, respectively. For the three months ended June 30, 2013, our effective rate differed from statutory tax rates primarily because of profits taxed in foreign jurisdictions with lower tax rates. For the three months ended June 30, 2012, our effective rate differed from statutory tax rates primarily due to discrete items coupled with losses in some foreign jurisdictions for which we did not record a tax benefit.

Six Months Ended June 30, 2013 and 2012

Revenues

Our consolidated revenue increased by $47.7 million or 40% to $168.1 million for the six months ended June 30, 2013, compared to $120.4 million in the comparable 2012 period. The increase was attributable to our recent acquisitions. Grass, acquired in February 2013 contributed $5.9 million of revenue in the six month period of 2013. Nicolet, acquired in July 2012 contributed $46.2 million of revenue in the six month period of 2013. Revenue from our products other than Grass and Nicolet, decreased by $4.4 million in 2013 compared to 2012. This decline was attributable to weak economic conditions in Europe coupled with a decline in domestic hospital capital spending and our emphasizing the sales of our newly acquired neurology products.

Revenue from our neurology products increased $49.9 million or 85% to $108.5 million in the six month period of 2013, compared to $58.6 million in the same period in 2012. Revenue from our neurology products, other than Grass and Nicolet products, decreased by $2.2 million for the six months ended June 30, 2013 compared to 2012. This decline was attributable to weak economic conditions in Europe and to our emphasizing the sales of our newly acquired neurology products. Revenue from our newborn care products decreased by $2.4 million, or 4% to $59.5 million in the six month period of 2013 compared to $61.9 million in the same period in 2012. This decline was primarily attributed to lower sales of newborn care devices and systems partially offset by an increase in newborn care supplies and services.

 

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Revenue from neurology devices and systems was $65.9 million for the six months ended June 30, 2013, representing an increase of 65% or $25.9 million, from $40 million reported in the six month period of 2012. Grass and Nicolet contributed to $27.6 million of the increase in neurology devices and systems while revenue from our neurology products other than Grass and Nicolet decreased by $1.7 million in the six month period of 2013 compared to the six month period of 2012, primarily attributable to a decrease in EMG systems revenue. Revenue from newborn care and other devices and systems was $33.1 million for the six months ended June 30, 2013, representing a decrease of 13% or $4.9 million, from $38 million reported in the six month period of 2012. This decline in newborn care devices and systems revenue was due to lower sales of newborn incubators, CFM and diagnostic hearing revenue.

Revenue from devices and systems was 59% of consolidated revenue in the six month period of 2013 compared to 65% of consolidated revenue in the six month period of 2012.

Revenue from neurology supplies was $30.7 million for the six months ended June 30, 2013 representing an increase of 84% or $14 million, from $16.7 million reported in the six month period of 2012. Grass and Nicolet contributed to $17.8 million of neurology supplies revenue. Neurology supplies revenue other than Grass and Nicolet, decreased by $3.8 million in the six month period of 2013 compared to the six month period of 2012. This decline was primarily attributable to a decrease in sleep supplies. Revenue from newborn care supplies was $23.1 million for the six months ended June 30, 2013, representing an increase of 5% or $1.2 million from $21.9 million reported in the six month period of 2012. This increase was comprised primarily of newborn care supplies.

Revenue from supplies was 32% of consolidated revenue in both six month periods of 2013 and 2012, respectively.

Revenue from neurology services was $12 million for the six months ended June 30, 2013 representing an increase of 531% or $10.1 million, from $1.9 million reported in the six month period of 2012. Grass and Nicolet contributed to $6.3 million of the increase in neurology services. Neurology services revenue other than Grass and Nicolet, increased by $3.8 million in the six month period of 2013 compared to the six month period of 2012. This increase was primarily attributable to an increase in Xltek neurology and Embla sleep services. Revenue from newborn care services was $3.3 million for the six months ended June 30, 2013, representing an increase of 65% or $1.3 million from $2 million reported in the six month period of 2012. This increase was primarily attributable to an increase in hearing and balance service revenue.

Revenue from services was 9% of consolidated revenue in the six month period compared to 3% of consolidated revenue in the six month period of 2012.

No single customer accounted for more than 10% of our revenue in either the six month period of 2013 or 2012. Revenue from domestic sales increased 49% to $96.2 million for the six months ended June 30, 2013 from $64.5 million in the six month period of 2012. Revenue from international sales increased 28% to $71.8 million for the six months ended June 30, 2013 compared to $56 million in the six month period of 2012. Revenue from domestic sales was 57% of total revenue for the six months ended June 30, 2013 compared to 54% of consolidated revenue in the six month period of 2012, and revenue from international sales was 43% of total revenue in the six month period of 2013 compared to 46% of consolidated revenue in the six month period of 2012.

Cost of Revenue and Gross Profit

Our cost of revenue increased $17.7 million or 34% to $70.5 million for the six months ended June 30, 2013 from $52.8 million in the six month period of 2012. Grass and Nicolet contributed $20.8 million to our cost of revenue offset by declines in cost of revenue declines across North America. Gross profit increased $30 million, or 44%, to $97.6 million in the six month period of 2013 from $67.7 million in the six month period of 2012 as a result of our increased sales. Gross profit as a percentage of revenue was 58.1% for the six months ended June 30, 2013 and 56.2% for the six months ending June 30, 2012 as a result of product mix, primarily as a result of a higher percentage of sales of neurology products which generally carry higher margins than our other products.

Operating Costs

Total operating costs increased $20 million or 30% to $86.6 million for the six months ended June 30, 2013, from $66.6 million in the six month period of 2012.The operating expense of Grass and Nicolet contributed to $18.6 million in operating costs. The newly enacted medical device tax in 2013 accounted for $2.5 million of the increase in operating costs partially offset by lower severance and acquisition related direct costs.

 

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Our marketing and selling expenses increased $11.1 million or 34% to $44 million in the six month period of 2013, from $32.9 million in the six month period of 2012. Marketing and selling expenses as a percent of total revenue decreased to 26.2% in the first six months of 2013 from 27.3% in the first six months of 2012. The marketing and selling expenses of Grass and Nicolet and was $11 million and accounted for the entire increase in marketing and selling expenses.

Our research and development expenses increased $3.5 million or 26% to $16.8 million for the six months ended June 30, 2013 from $13.3 million for the six months ended June 30, 2012. Research and development expenses as a percent of total revenue decreased to 10% in the six month period of 2013 from 11.1% in the in the six month period of 2012. The research and development expenses of Grass and Nicolet were $4.2 million for the six months ended June 30, 2013, partially offset by lower employee compensation costs resulting from cost cutting activities initiated in 2012 in our other operations.

Our general and administrative expenses increased $5.4 million or 26% to $25.8 million for the six months ended June 30, 2013 from $20.4 million for the six months ended June 30, 2012. General and administrative expenses as a percent of revenue decreased to 15.4% in the six month period of 2013 from 16.9% in the six month period of 2012. The general and administrative expense of Grass and Nicolet was $3.3 million. The newly enacted medical device tax in 2013 accounted for $2.5 million of the increase in general and administrative expenses.

Other Income (Expense), net

Other income (expense), net consists of investment income, interest expense, net currency exchange gains and losses, and other miscellaneous income and expense. We reported other income (expense), net of $(856,000) for the six months ended June 30, 2013, compared to $477,000 for the six months ended June 30, 2012. We reported $50,000 of foreign currency exchange losses in the six month period of 2013 versus $356,000 of foreign exchange gains in the six month period of 2012. Interest expense was $946,000 for the six months ended June 30, 2013 compared to $16,000 for the six months ended June 30, 2012 due primarily to borrowings to fund the Nicolet and Grass acquisitions.

Provision for Income Tax

We recorded a provision for income tax of $2.7 million and $909,000 for the six months ended June 30, 2013 and 2012, respectively. The increase in tax expense for the six months ended June 30, 2013 compared to the six month period of 2012 is primarily attributable to the increase in income before provision for income taxes. Our effective tax rate was 26.6% and 59.7% for the six months ended June 30, 2013 and 2012, respectively. For the six months ended June 30, 2013 our effective rate differed from statutory tax rates primarily because of profits taxed in foreign jurisdictions with lower tax rates than the statutory rate and tax benefits of approximately $340,000 derived from the recognition of the 2012 federal research and development tax credit by enactment of the American Taxpayer Relief Act of 2012 in January 2013. For the six months ended June 30, 2012, our effective rate differed from statutory tax rates primarily due to discrete items coupled with losses in some foreign jurisdictions for which we did not record a tax benefit.

Liquidity and Capital Resources

As of June 30, 2013, we had cash and cash equivalents of $28.9 million and working capital of $98 million, compared with cash and cash equivalents of $23.1 million and working capital of $70.5 million as of December 31, 2012. The increase in working capital resulted primarily from refinancing $11.3 million of short-term borrowings to long-term debt and a $15.7 million reduction in accounts payable and accrued expenses.

As of June 30, 2013, we had cash and cash equivalents outside the U.S. in certain of our foreign operations of approximately $13.2 million. We currently intend to permanently reinvest the cash held by our foreign subsidiaries. If, however, a portion of these funds were needed for and distributed to our operations in the United States, we would be subject to additional U.S. income taxes and foreign withholding taxes. The amount of taxes due would depend on the amount and manner of repatriation, as well as the location from where the funds are repatriated.

At June 30, 2013 the Company had a $75 million credit facility consisting of a $25 million revolving credit line and a $50 million 5-year term loan with Wells Fargo Bank, National Association (“Wells Fargo”). The credit facility contains covenants, including covenants relating to liquidity and other financial measurements, and provides for events of default, including failure to pay any interest when due, failure to perform or observe covenants, bankruptcy or insolvency events, and the occurrence of a material adverse effect, and restricts our ability to pay dividends. We have granted Wells Fargo a security interest in substantially all of our assets. We have no other significant credit facilities.

 

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In February 2013, we acquired through an asset purchase for a cash price of $18.6 million the Grass Technology Product Group from Astro-Med Inc. We funded this acquisition with a combination of cash-on-hand and an $18 million borrowing under the credit facility.

We believe that our current cash and cash equivalents and any cash generated from operations will be sufficient to meet our ongoing operating requirements for the foreseeable future.

Cash provided by operations decreased by $10 million to $4 million for the six months ended June 30, 2013 compared to an increase of $7.1 million for the same period in 2012. The sum of our net income and certain non-cash expense items, such as reserves, depreciation and amortization, and share based compensation was approximately $17.6 million for the six months ended June 30, 3013, compared to $10.5 million in the 2012. The overall impact of changes in certain operating assets and liabilities on total operating cash flows resulted in a cash outflow of $12.5 million in the six months ended June 30, 2013 compared with a cash inflow of $3.4 million in the 2012 period. In particular, our cash flow from operations in the six months of 2013 was negatively impacted by a $9.5 million decrease in accrued expenses and deferred revenue, a $6.5 million decrease in accounts payable partially offset by a $4.6 million decrease in accounts receivable and $6.8 million higher net income.

Cash used by investing activities was $20.9 million for the six months ended June 30, 2013, compared to cash used by investing activities of $60 million for the same period in 2012. We used $18.6 million to acquire Grass during the six months ended June 30, 2013 and we used $57.9 million to acquire Nicolet during the six months ended June 30, 2012. We used $1.5 and $2.3 million of cash to acquire property and equipment during the six months ended June 30, 2013 and 2012, respectively.

Cash provided by financing activities was $22.6 million in the six months ended June 30, 2013, compared to cash $31.1 million in the six months ended June 30, 2012. In February 2013 we borrowed $18 million of cash on our credit facility to partially fund the acquisition of Grass and had additional short-term borrowings of $4 million which we refinanced together with the $5 million of short-term borrowings associated with the Nicolet acquisition in 2012 as long-term borrowings as of June 30, 2013. In June 2012 we borrowed $31 million of cash on our credit facility to partially fund the acquisition of Nicolet for which $8 million has been repaid. We received cash from sales of our stock pursuant to exercise of stock options and contributions to our employee stock purchase plan in the amount of $3.8 million and $770,000 in the six months ended June 30, 2013 and 2012, respectively.

Our future liquidity and capital requirements will depend on numerous factors, including the:

 

   

Extent to which we make acquisitions;

 

   

Amount and timing of revenue;

 

   

Extent to which our existing and new products gain market acceptance;

 

   

Cost and timing of product development efforts and the success of these development efforts;

 

   

Cost and timing of marketing and selling activities; and

 

   

Availability of borrowings under line of credit arrangements and the availability of other means of financing.

Commitments and Contingencies

In the normal course of business, we enter into obligations and commitments that require future contractual payments. The commitments result primarily from firm, noncancellable purchase orders placed with contract vendors that manufacture some of the components used in our medical devices and related disposable supply products, as well as commitments for leased office, manufacturing, and warehouse facilities. The only material change to the table of contractual obligations presented in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December 31, 2012 has been the result of $22 million of debt incurred from borrowings against the credit facility as of June 30, 2013.

Under our bylaws, we have agreed to indemnify our officers and directors for certain events or occurrences arising as a result of the officer or director’s serving in such capacity. We have a directors and officers’ liability insurance policy that limits our exposure and enables us to recover a portion of any future amounts paid resulting from the indemnification of our officers and directors. In addition, we enter into indemnification agreements with other parties in the ordinary course of business. In some cases we have obtained liability insurance providing coverage that limits our exposure for these other indemnified matters. We have not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. We believe the estimated fair value of these indemnification agreements is minimal and have not recorded a liability for these agreements

 

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Recent Accounting Pronouncements

See Note 1 to our Condensed Consolidated Financial Statements for a discussion of new accounting pronouncements that affect us.

Cautionary Information Regarding Forward Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 about Natus Medical Incorporated. These statements include, among other things, statements concerning our expectations, beliefs, plans, intentions, future operations, financial condition and prospects, and business strategies. The words “may,” “will,” “continue,” “estimate,” “project,” “intend,” “believe,” “expect,” “anticipate,” and other similar expressions generally identify forward-looking statements. Forward-looking statements in this Item 2 include, but are not limited to, statements regarding the following: our belief that the recovery from the worldwide economic downturn has continued, our expectation regarding expansion of our international operations, our expectations regarding our new products, the sufficiency of our current cash, cash equivalents, and short-term investment balances, and any cash generated from operations to meet our ongoing operating and capital requirements for the foreseeable future, the use of debt to fund acquisitions, our expectations of earnout arrangements related to acquisitions, and our intent to acquire additional technologies, products, or businesses.

Forward-looking statements are not guarantees of future performance and are subject to substantial risks and uncertainties that could cause the actual results predicted in the forward-looking statements as well as our future financial condition and results of operations to differ materially from our historical results or currently anticipated results. Investors should carefully review the information contained under the caption “Risk Factors” contained in Part II, Item 1A of this report for a description of risks and uncertainties. All forward-looking statements are based on information available to us on the date hereof, and we assume no obligation to update forward-looking statements.

 

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

We develop products in the U.S., Canada, Argentina, and Europe and sell those products into more than 100 countries throughout the world. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Most of our sales in Europe and Asia are denominated in U.S. Dollars and Euros and with the acquisitions of Xltek in 2007, Medix in 2010 and Nicolet in 2012, a small portion of our sales are now denominated in Canadian dollars, Argentine pesos and British pounds. As our sales in currencies other than the U.S. Dollar increase, our exposure to foreign currency fluctuations may increase.

In addition, changes in exchange rates also may affect the end-user prices of our products compared to those of our foreign competitors, who may be selling their products based on local currency pricing. These factors may make our products less competitive in some countries.

If the U.S. Dollar uniformly increased or decreased in strength by 10% relative to the currencies in which our sales were denominated, our net income would have correspondingly increased or decreased by an immaterial amount for the six months ended June 30, 2013. Our interest income is sensitive to changes in the general level of interest rates in the U.S. However, because current market conditions have resulted in historically low rates of return on our investments, a hypothetical decrease of 10% in market interest rates would not result in a material decrease in interest income earned on our investments held as of June 30, 2013.

When feasible, we invest excess cash in bank money-market funds or discrete short-term investments. The fair value of short-term investments and cash equivalents (“investments”) is sensitive to changes in the general level of interest rates in the U.S., and the fair value of these investments will fall if market interest rates increase. However, since we generally have the ability to hold the investments to maturity, these declines in fair value may never be realized. If market interest rates were to increase by 10% from levels at June 30, 2013, the fair value of our investments would decline by an immaterial amount.

All of the potential changes noted above are based on sensitivity analyses performed on our financial position as of June 30, 2013. Actual results may differ as our analysis of the effects of changes in interest rates does not account for, among other things, sales of securities prior to maturity and repurchase of replacement securities, the change in mix or quality of the investments in the portfolio, and changes in the relationship between short-term and long-term interest rates.

 

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ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, under the supervision of our Chief Executive Officer and Chief Financial Officer and with the participation of our disclosure committee, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2013. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of June 30, 2013 at the reasonable assurance level due to a material weakness that we identified as of December 31, 2012 that has not been remediated. The material weakness relates to our controls over the implementation of a single-platform enterprise resource planning (“ERP”) application for our operations in North America exclusive of Nicolet. In particular, we did not perform adequate user acceptance testing prior to implementing this application to identify processes that were later discovered to not operate as designed. This resulted in an inadequate segregation of duties and inadequate controls over approval of certain journal entries based on the roles assigned to users of the ERP. In addition, given the system implementation issues, we were not able to timely prepare account analyses and reconciliations.

These factors prevented us from completing our financial close and preparation of financial statements on a timely basis, which, in turn, made us unable to file our financial statements by the due date required by the applicable rules and regulations established by the Securities and Exchange Commission.

Management’s Remediation Activities

To remediate the material weakness in our internal control over financial reporting described above, we are developing and implementing new control procedures regarding our ongoing implementation of the ERP application, including the following: (i) devoting additional resources to fixing processes associated with the financial close that were not operating as designed, (ii) revising user roles to provide adequate separation of duties, appropriate approval levels, and review of manual transaction details, and (iii) developing detailed reports to facilitate accurate account analyses and timely reconciliation of accounts. However, the material weakness will not be considered remediated until the applicable remedial controls operate for a sufficient period of time and management has concluded, through testing, that the controls are operating effectively.

Changes in Internal Control over Financial Reporting

Other than the actions taken as described above under “Management’s Remediation Activities,” there were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, even if determined effective and no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives to prevent or detect misstatements. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

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PART II. OTHER INFORMATION

 

ITEM 1. Legal Proceedings

We may from time to time become a party to various legal proceedings or claims that arise in the ordinary course of business. Our management reviews these matters if and when they arise and believes that the resolution of any such matters currently known will not have a material effect on our results of operations or financial position.

 

ITEM 1A. Risk Factors

A description of the risks associated with our business, financial condition and results of operations is set forth in Part 1, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012. There have been no material changes in our risks from such description.

 

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ITEM 6. Exhibits

(a) Exhibits

 

         Incorporated By Reference  

Exhibit

No.

 

Exhibit

   Filing      Exhibit
No.
     File No.      File Date  
  10.1*   Form of Employment Agreement between Natus Medical Incorporated and Jonathan A. Kennedy dated April 8, 2013            
  10.2*   Amended Employment Agreement between the Company and James B. Hawkins dated April 19, 2013      8-K         99.1         000-33001         04/19/2013   
  10.3   Fourth Amended and restated Credit Agreement, dated as of June 28, 2013, between Natus Medical Incorporated and Wells Fargo Bank, National Association      8-K         10.1         000-33001         07/05/2013   
  31.1   Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002            
  31.2   Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002            
  32.1   Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002            
101.INS**   XBRL Instance Document            
101.SCH**   XBRL Taxonomy Extension Schema Document            
101.CAL**   XBRL Taxonomy Extension Label Calculation Linkbase Document            
101.LAB**   XBRL Taxonomy Extension Label Linkbase Document            
101.PRE**   XBRL Taxonomy Extension Presentation Linkbase Document            
101.DEF**   XBRL Taxonomy Extension Definition Document            

 

* Indicates a management contract or compensatory plan or arrangement.

 

** Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Annual Report on Form 10-K shall not be deemed to be “filed” for purposes of section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act or Exchange Act, except as may be expressly set forth by specific reference in such filings.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    NATUS MEDICAL INCORPORATED
Dated:     August 8, 2013     By:  

 /s/ James B. Hawkins

     

James B. Hawkins

Chief Executive Officer

(Principal Executive Officer)

Dated:     August 8, 2013     By:  

 /s/ Jonathan A. Kennedy

     

Jonathan A. Kennedy

Senior Vice President Finance and

Chief Financial Officer

(Principal Financial and

Accounting Officer)

 

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NATUS MEDICAL INCORPORATED

INDEX TO EXHIBITS

 

         Incorporated By Reference  

Exhibit
No.

 

Exhibit

   Filing      Exhibit
No.
     File No.      File Date  
  10.1*   Form of Employment Agreement between Natus Medical Incorporated and Jonathan A. Kennedy dated April 8, 2013            
  10.2*   Amended Employment Agreement between the Company and James B. Hawkins dated April 19, 2013      8-K         99.1         000-33001         04/19/2013   
  10.3   Fourth Amended and restated Credit Agreement, dated as of June 28, 2013, between Natus Medical Incorporated and Wells Fargo Bank, National Association      8-K         10.1         000-33001         07/05/2013   
  31.1   Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002            
  31.2   Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002            
  32.1   Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002            
101.INS**   XBRL Instance Document            
101.SCH**   XBRL Taxonomy Extension Schema Document            
101.CAL**   XBRL Taxonomy Extension Label Calculation Linkbase Document            
101.LAB**   XBRL Taxonomy Extension Label Linkbase Document            
101.PRE**   XBRL Taxonomy Extension Presentation Linkbase Document            
101.DEF**   XBRL Taxonomy Extension Definition Document            

 

* Indicates a management contract or compensatory plan or arrangement.

 

** Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Annual Report on Form 10-K shall not be deemed to be “filed” for purposes of section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act or Exchange Act, except as may be expressly set forth by specific reference in such filings.

 

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